The rupee continued to fall on Wednesday despite an import duty hike on gold and silver to curb its slide. The currency slumped to fresh record low of 95.81 against the dollar, indicating that the import duty hike—to 15 percent from 6 percent—may not be enough to cushion against its free fall.
“There was some initial limited relief for the Indian rupee in the wake of the increase in the import tax on gold and silver. However, while it is supportive at the margin, it may do little to stem the underlying pressure on the currency,” says Mitul Kotecha, head of forex and EM Macro Strategy Asia, Barclays.
He adds that if demand for gold remains low while prices stay high, it will do little to narrow the trade deficit. “The Indian rupee remains highly sensitive to oil prices, and unless oil prices decline or imports are reduced due to demand destruction, the pressure on India’s balance of payments may not ease quickly.” Kotecha estimates that a 10 percent fall in oil prices will lead to a 0.5 percent appreciation of the rupee on average versus the US dollar, assuming other factors remain constant.
The strain on India’s domestic currency runs deep and is likely to persist as the factors driving its depreciation remain intricate, complex and multifaceted. The Indian rupee is the weakest currency in Asia, reflecting broader economic concerns. “As long as oil prices do not cool off and tensions escalate further, the rupee could face additional pressure. However, a swift resolution of the West Asia crisis would likely reverse this downtrend,” says Anindya Banerjee, head of commodity and currency research, Kotak Securities.
The twin pressures of a higher oil import bill and foreign institutional investors (FIIs) outflows are driving up demand for the dollar and pulling down the rupee. Banerjee says that if oil prices continue to rise, dollar-rupee exchange rate could go higher, although the RBI is expected to intervene at higher levels.
One of the key reasons for the sharp depreciation of the rupee is the ongoing West Asia crisis, which has now stretched over two and a half months and pushed up crude prices as shipping disruptions hit the Strait of Hormuz, a critical route for global oil shipments. While most currencies have weakened—with a few exceptions such as the Brazilian Real, the Chinese Yuan, and the British Pound—Asian currencies have taken a bigger hit compared to the global peers, given their exposure to the crisis. This year so far, the rupee has lost 6.11 percent, falling 0.8 percent in May alone.
“While such depreciation is largely expected amid rising energy prices and capital flows shifting towards safe-haven assets like the US dollar, the weakness in the Indian rupee has been a more persistent concern over the past year, even before the conflict,” say analysts at CareEdge. The recent escalation in tensions in West Asia has only intensified these pressures.
The persistent weakness in the rupee is evident from its 11 percent depreciation over the past year, with 4.7 percent decline occurring since the war in West Asia started end-February.
Weak capital flows in the last year have been a major factor behind the weakening pressure on the rupee. There is continuous drain-out of FII money from Indian markets: FIIs recorded outflows of $5.9 billion in April alone, while the total outflows so far from Indian stocks stood at $21.7 billion.
According to analysts at Tata Mutual Fund, unless geopolitical risks ease and crude prices retrace meaningfully, the rupee is likely to retain a depreciating bias, with implications for imported inflation.
In the last few weeks, crude oil prices have breached $100 per barrel while the rupee has crossed Rs95 to the dollar, exerting intense pressure on India’s current account deficit, balance of payment, forex reserves and the overall fiscal health of the economy. Crude oil and gold remain India’s two largest imports by value, and a sustained 50 percent rise in crude prices materially worsens external balances. Every $10 per barrel increase in crude is estimated to add 45 basis points to retail inflation and widen the current account deficit by 30–40 bps, as per analysts at Tata Mutual Fund.
Radhika Rao, senior economist, DBS Bank, cautions that a collapse in oil prices or a resumption in portfolio flows (FII) are pre-requisites for a durable turnaround in the rupee’s bearish run. “Markets are pricing in rate hikes to defend the rupee and address potential inflationary pressures, although we do not expect policy tightening to be the immediate response,” she says.
Rao adds that policy actions outside conventional rate hikes will be tapped to anchor the currency. She points to three possibilities: The removal of withholding tax for foreign investors in sovereign bonds; foreign currency bond issuances by state banks on hedged basis; and deposit scheme to draw in non-resident deposits, backed by concessional swap rates to banks (which will necessitate a higher subsidy by the RBI in the context of higher US rates currently vs 2013).
“These tools will help buffer the financing mix under the balance of payment, though [they will] do little to revive the risk-sensitive portfolio or reverse net FDI. Beyond this, the RBI policy committee still retains scope for calibrated rate hikes if inflationary pressures intensify. In the near term, currency movements will be subject to headlines and prone to weakness till outflows reverse,” Rao says.
Meanwhile, a combination of these global and domestic pressures continues to weigh on longer-duration yields. The benchmark 10-year government bond yield has been oscillating within a narrow band of 6.9 percent to 7.1 percent, with intermittent spikes. In contrast, the shorter-duration government securities, particularly in the one- to three-year segment, have shown stability and low volatility.
“The debt market is expected to remain influenced by a mix of external and domestic factors. The 10-year yield is likely to continue moving within the 6.9–7.1 percent range, with upside risks if crude prices remain elevated or the rupee weakens further,” says Sneha Pandey, fund manager, fixed income, Quant Mutual Fund.
Inflation: Deceptive comfort or delayed pain?
Despite weak external factors, the retail inflation in April showed resilience. The Consumer Price Index (CPI), or retail inflation, edged up marginally to 3.48 percent year-on-year in April from 3.40 percent in March. A few economists call it a ‘deceptive comfort’, assuming that latent inflationary pressures are steadily building. Adding to the risks are harsh summers in April and May, the possibility of El Nino and a weak monsoon, and the import duty hike on gold and silver widening inflation.
“The current inflation comfort appears increasingly disconnected from underlying cost dynamics. Rising global energy prices, sharp increases in commercial LPG, ATF and freight-linked fuel costs, along with persistent rupee depreciation, are beginning to feed into logistics, airfares, processed food and FMCG packaging costs, although the pass-through to consumer prices remains incomplete so far,” say economists at QuantEco Research.
Aastha Gudwani, India chief economist, Barclays, feels the import duty hike on gold and silver to curb non-essential demand will likely add 10 basis points to headline CPI. She does not expect the hike to materially lower the gold import bill, given the elevated international prices.
The surge in gold prices and the intermittent high volumes have significantly increased the import bill. Gold and silver imports rose to $102.5 billion in FY25-26, up 26.7 percent YoY, with their share in total imports rising to 14 percent from 11.8 percent in FY24-25.
However, this is not the first time the government has resorted to an increase in duties to arrest non-essential demand, especially as external account faces mounting pressure amid the prolonged West Asia conflict. In July 2022, the basic customs duty on gold was raised to 12.5 percent from 7.5 percent, bringing total import taxes to 15 percent (up from 10.75 percent) as the current account deficit came under pressure amid higher gold imports. Right after, volumes slipped 41 percent YoY and continued to decline consistently until February 2023. However, the duty was reduced to 6 percent in July 2024, as the pressures tapered.
According to Sanjeev Prasad, MD and co-head, Kotak Institutional Equities, the government may have limited options to manage the immediate pressures on current account deficit and balance of payments without taking ‘harsh’ measures, which would have a negative impact on some part of the economy. “We can only see certain taxation measures in the short term that can reduce imports of certain items or increase capital flows,” he says.
Shocks to equity?
The Indian market has been fairly nonchalant about the West Asia war, with over a 7 percent rally of benchmark indices Sensex and Nifty in April. The retail sentiment has been unusually bullish based on continued strong inflows into domestic equity mutual funds despite hardly any returns over 18 months. However, the overall markets have remained tepid in May so far.
However, Riddham Desai, equity strategist, Morgan Stanley, is optimistic. He feels that with growth acceleration likely in the pipeline and valuations and sentiment at near extremes, Indian equities are poised for a strong year ahead.
He explains the tide in earnings is turning after a six-quarter mid-cycle slowdown and is likely to accelerate further, driven by reflationary policies of the RBI and the government via rate cuts, bank deregulation and liquidity infusion, strong capex trends in energy, defence, semiconductors, fertilisers and data centres among others, and large tax cuts and relatively stimulating fiscal. “Thus, India’s hawkish macro set up post-Covid, which drove apathy towards the Indian market, has unwound,” Desai says. He acknowledges that the lack of a direct AI play seems to be the most persistent challenge to the equity market, with potential AI disruption for Indian services exports aggravating matters.
“The key risks to India are mostly external, including geopolitical tensions and slowing global growth. Back home, we worry about the low productivity in farming, capacity constraints in the judiciary, and embodied AI hitting the labour market,” he says.
In the last 12 months to April, the Nifty has delivered a return of -1.4 percent while FY26 and FY27 earnings per share (EPS) have been cut by 7.3 percent and 5.7 percent, respectively. In April, EPS estimates for FY26 and FY27 fell by 1.2 percent and 1.6 percent month-on-month, respectively.
“Compared to the North Asian markets, India offers a less attractive risk/reward as it trades at significantly higher growth-adjusted valuations, on top of the ongoing investor concerns over the potential adverse impact of AI,” says Timothy Moe, co-head of Asia macro research and chief Asia-Pacific equity strategist, Goldman Sachs, in note a co-authored with Amorita Goel and Sunil Koul. They think the downside risk to FIIs selling Indian shares over the near term, in case the West Asia war prolongs, could be about $4 billion.
